Date: July 15, 2015

Chinese Market Collapse Not Over

I remember the outrage when the government sought to pull off TARP in 2008, first buying troubled, illiquid assets from the big banks which then morphed into outright capital injections into the banks. When QE was announced, the calls were equally as emotional, not to mention the myriad of special Fed programs designed to provide liquidity in the financial system when there was little.

I can only imagine what those naysayers believe now regarding China.

This is not a new topic here, but I do want to reiterate my own analysis about the collapse in the Chinese stock market. I have seen interesting comparisons to China’s stock market right now and ours during the crash of 1929 period. For now, they seem to line up very nicely and suggests further downside. However, a note of caution; eventually, all market comps break apart.

The Chinese are not experienced in dealing with the pitfalls of an almost free market financial system, but they are certainly smart enough not to make the same mistakes we did to cause the Great Depression. It does seem, however, that they believe they can manipulate their way back to a bull market in stocks, something our government learned was impossible in 2007 and 2008.

After the Shanghai Index peaked on June 12 and began to spiral lower, the Chinese government started a series of measures to curb selling. They shelved all IPOs. The 21 largest brokerages created a consortium to inject money into stocks. When both failed, the government prevented large shareholders (5% or more) from selling any stock for six months. As all this unfolded, hundreds of non state owned, non blue chip companies requested that their stocks be suspended from trading until volatility subsided. At last count, those companies numbers roughly 700.

Market bottoms do not end with increased manipulation and a lack of liquidity. There are billions, if not trillions, in pent up selling demand waiting to be unleashed if and when the Shanghai begins to function semi-normally. Just like the Bank of England and Bank of Switzerland learned, you can’t ultimately prevent investors from selling no matter how hard you try.

I would also argue that had they left the free market to determine price, the Chinese market might have crashed like ours did in 1987, but the bottoming period would already have begun. Now, with the Shanghai down 28% from high to low and the smaller indices much more, it looks like that market is ultimately headed at least 5-10% lower than the lows so far, if not a whole lot more this year.

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Paul Schatz, President, Heritage Capital